10 Fixed Assets and Intangible Assets Principles of Financial Accounting, 11e Reeve Warren Duchac.

10

Fixed Assets and Intangible Assets

Principles of Financial Accounting, 11eReeve • Warren • Duchac

Learning Objective 13-1

Describe the nature of the adjusting process.

Learning Objective 13-1

Describe the nature of the adjusting process.

Insert Chapter Objectives

Fixed Assets and Intangible Assets

1 Define, classify, and account for the cost of fixed assets.

2 Compute depreciation, using the following methods: straight-line method, units-of-production method, and double-declining-balance method.

3 Journalize entries for the disposal of fixed assets.

After studying this chapter, you should be able to:

10-2

Fixed Assets and Intangible Assets (continued)

4 Compute depletion and journalize the entry for depletion.

5 Describe the accounting for intangible assets, such as patents, copyrights, and goodwill.

6 Describe how depreciation expense is reported in an income statement and prepare a balance sheet that includes fixed assets and intangible assets.

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10-4

Describe, classify, and account for the cost of fixed assets.

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10-4

10-5

Nature of Fixed Assets

Fixed assets are long-term or relatively permanent assets, such as equipment, machinery, buildings, and land. Other descriptive titles for fixed assets are plant and equipment.

1

10-6

Fixed assets have the following characteristics:1. They exist physically and, thus, are

tangible assets.2. They are owned and used by the

company in its normal operations.3. They are not offered for sale as part of

normal operations.

1

10-7

1

Classifying CostsExhibit 2

10-8

1

Costs of Acquiring Fixed AssetsExhibit 3

(continued)

10-9

1

Costs of Acquiring Fixed Assets (continued)Exhibit 3

(continued)

10-10

1


(continued)

10-11

1


10-12

Cost of Acquiring Fixed Assets Excludes:

1. Vandalism

These costs are expenses.

2. Mistakes in installation

4. Damage during unpacking and installing

3. Uninsured theft

5. Fines for not obtaining proper permits from government agencies

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10-13

• Expenditures that benefit only the current period are called revenue expenditures.

1

Capital and Revenue Expenditures

• Expenditures that improve the asset or extend its useful life are capital expenditures.

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Normal and ordinary repairs and maintenance

REVENUE EXPENDITURES

1

CAPITAL EXPENDITURES

Additions, improvements, and extraordinary repairs

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Ordinary Maintenance and Repairs

On April 9, the firm paid $300 for a tune-up of a delivery truck.

1

This is a revenue expenditure.

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Asset Improvements

On May 4, a $5,500 hydraulic lift was installed on the delivery truck to allow for easier and quicker loading of heavy cargo.

This is a capital expenditure.

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10-17

Extraordinary Repairs

The engine of a forklift that is near the end of its useful life is overhauled at a cost of $4,500, which extends its useful life eight years. Work on the forklift was completed on October 14.

1

This is a capital expenditure.

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Capital and Revenue Expenditures1

10-19

Example Exercise 10-1Capital and Revenue Expenditures

On June 18, GTS Co. paid $1,200 to upgrade a hydraulic lift and $45 for an oil change for one of its delivery trucks. Journalize the entries for the hydraulic lift upgrade and oil change expenditures.

1

10-20

Example Exercise 10-1

Follow My Example 6-1


June 18 Delivery Truck…………………........ 1,200Cash……………………………... 1,200

18 Repairs and Maintenance Exp…… 45Cash…………………………......... 45

For Practice: PE 10-1A, PE 10-1B

10-20

Leasing Fixed Assets

A capital lease is accounted for as if the lessee has, in fact, purchased the asset. The asset is then amortized over the life of the capital lease.

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10-21

A lease that is not classified as a capital lease for accounting purposes is classified as an operating lease (an operating lease is treated as an expense).

1

Leasing Fixed Assets

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2

10-23

Compute depreciation, using the following methods: straight-line method, units-of-production method, and double-declining balance method.

10-23

Over time, fixed assets such as equipment, buildings, and land improvements lose their ability to provide services. The periodic recording of the cost of fixed assets to expense is called depreciation.

2

Depreciation

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1. Physical depreciation factors include wear and tear during use or from exposure to the weather.

2. Functional depreciation factors include obsolescence and changes in customer needs that cause the asset to no longer provide services for which it was intended.

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• Depreciation does not measure a decline in the market value of a fixed asset.

• Depreciation does not provide cash to replace fixed assets as they wear out.

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Factors in Computing Depreciation

1. The asset’s initial cost.

2. The asset’s expected useful life.

3. The asset’s estimated residual value.

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The expected useful life of a fixed asset is estimated at the time the asset is placed into service. The residual value of a fixed asset at the end of its useful life is estimated at the time the asset is placed into service.

2

Residual Value

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2

Depreciation Expense FactorsExhibit 4

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2

Use of Depreciation MethodsExhibit 5

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Straight-Line Method

The straight-line method provides for the same amount of depreciation expense for each year of the asset’s useful life.

Annual depreciation

Cost – estimated residual valueEstimated life

=

2

10-31

A depreciable asset cost $24,000. Its estimated residual value is $2,000 and its estimated useful life is five years.

Annual depreciation

Cost – estimated residual valueEstimated life

=

Annual depreciation

$24,000 – $2,000 5 years expected useful life

=

Annual depreciation

= $4,400

2

10-32

If the preceding equipment was purchased and placed into service on October 1, the depreciation would be $1,100, computed as follows:

$4,400 × 3/12 = $1,100

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10-33

Example Exercise 10-2Straight-Line Depreciation

2

Equipment acquired at the beginning of the year at a cost of $125,000 has an estimated residual value of $5,000 and an estimated useful life of 10 years. Determine the (a) depreciable cost, (b) straight-line rate, and (c) annual straight-line depreciation.





a. $120,000 ($125,000 – $5,000)

b. 10% = 1/10

c. $12,000 ($120,000 × 10%) or ($120,000 ÷ 10 years)

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10-34

Units-of-Production Method

The units-of-production method provides for the same amount of depreciation expense for each unit produced or each unit of capacity used by the asset.

Depreciation

per unitCost – Residual Value

Total Units of Production=

22

10-35

A depreciable asset cost $24,000. Its estimated residual value is $2,000 and it is expected to have an estimated life of 10,000 operating hours.

Depreciation

per unitCost – Residual Value

Total units of production=

Depreciation

per unit$24,000 – $2,000

10,000 hours expected useful life

=

Depreciation per unit = $2.20 per hour

2

10-36

A depreciable asset cost $24,000. Its estimated residual value is $2,000 and it is expected to have an estimated life of 10,000 operating hours. During the year the asset was operated 2,100 hours.

Depreciation

Depreciation per Unit × Total Units of Production Used=

Depreciation ($2.20 per hour) × (2,100

hours)=

Depreciation

$4,620=

2

10-37

Example Exercise 10-3Units-of-Production Depreciation

2

Equipment acquired at a cost of $180,000 has an estimated residual value of $10,000, an estimated useful life of 40,000 hours, and was operated 3,600 hours during the year. Determine the (a) depreciable cost, (b) depreciation rate, and (c) the units-of-production depreciation for the year.

10-38

Example Exercise 10-2 Example Exercise 10-3


a. $170,000 ($180,000 – $10,000)

b. $4.25 per hour ($170,000 ÷ 40,000 hours)

c. $15,300 (3,600 hours × $4.25)


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Double-Declining-Balance Method

The double-declining-balance method provides for a declining periodic expense over the estimated useful life of the asset.

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10-39

A double-declining balance rate is determined by doubling the straight-line rate. A shortcut to determining the straight-line rate is to divide one by the number of years (1/5 = .20). Hence, using the double-declining- balance method, a five-year life results in a 40 percent rate (.20 × 2).

2

(continued)

10-40

For the first year, the cost of the asset is multiplied by 40 percent. After the first year, the declining book value of the asset is multiplied 40 percent. Continuing with the example where the fixed asset cost $24,000 and has an expected residual value of $2,000, a table can be built.

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$24,000 × .40

1 $24,000 40% $9,600

2

Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End

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1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760

$14,400 × .40

2


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1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640

2


10-44

1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640

3 8,640 40% 3,456 18,816 5,184

2


10-45

1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640

3 8,640 40% 3,456 18,816 5,184

4 5,184 40% 2,074 20,890 3,110

2


10-46

1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640

3 8,640 40% 3,456 18,816 5,184

4 5,184 40% 2,074 20,890 3,110

5 3,110 40% 1,244 22,134 1,866

2

DEPRECIATION STOPS WHEN BOOK VALUE EQUALS RESIDUAL VALUE! STOPSTOP


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1 $24,000 40% $9,600 $9,600 $14,400

2 14,400 40% 5,760 15,360 8,640

3 8,640 40% 3,456 18,816 5,184

4 5,184 40% 2,074 20,890 3,110

5 3,110 – $2,000 1,110 22,000 2,000

Desired ending book

value

“Forced” annual

depreciation

2


10-48

If the preceding equipment was purchased and placed into service on October 1, depreciation for the year ending December 31 would be $2,400, computed as follows:

$9,600 × 3/12 = $2,400

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10-49

The depreciation for the second year would then be $8,640, computed as follows:

$8,640 = [40% × ($24,000 – $2,400)]

2

10-50

Example Exercise 10-4Double-Declining-Balance Depreciation

2

Equipment acquired at the beginning of the year at a cost of $125,000 has an estimated residual value of $5,000 and an estimated useful life of 10 years. Determine the (b) double-declining-balance rate, and (c) double-declining balance depreciation for the first year.



a. 20% [(1/10) × 2]

b. $25,000 ($125,000 × 20%)

For Practice: PE 10-4A, PE 10-4B10-51

10-51

Journalize entries for the disposal of fixed assets.

3

10-63

10-52

Discarding Fixed Assets

A piece of equipment acquired at a cost of $25,000 is fully depreciation at December 31, 2009. On February 14, 2010, the equipment is discarded.

3

10-53

Equipment costing $6,000, with no residual value, is depreciated at an annual straight-line rate of 10%. After the December 31, 2009, adjusting entry, Accumulated Depreciation—Equipment has a $4,750 balance. On March 24, 2010, the asset is removed from service and discarded.

$600 × 3/12

3

10-54

The discarding of the equipment is then recorded as follows (note that this is the second of two entries on March 24):

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10-55

Selling Fixed Assets

Equipment was purchased at a cost of $10,000. It had no estimated residual value and was depreciated at a straight-line rate of 10%. The equipment is sold for cash on October 12 of the eighth year of its use. The balance of the accumulated depreciation account as of the preceding December 31 is $7,000.

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10-56

The entry to update the depreciation for the nine months of the current year is as follows:

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10-57

The equipment is sold on October 12 for $2,250. No gain or loss.

Assumption 1

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10-58

Assumption 2

The equipment is sold on October 12 for $1,000; a loss of $1,250.

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10-59

Assumption 3

The equipment is sold on October 12 for $2,800; a gain of $550.

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10-60

Equipment was acquired at the beginning of the year at a cost of $91,000. The equipment was depreciated using the straight-line method based upon an estimated useful life of 9 years and an estimated residual value of $10,000.a. What was the depreciation for the first year?b. Assuming the equipment was sold at the end of

the second year for $78,000, determine the gain or loss on sale of the equipment.

c. Journalize the entry to record the sale.


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Sale of Equipment

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Example Exercise 10-6 (continued)

10-73


c. Cash…………………………………………… 78,000Accum. Depreciation—Equipment............ 18,000

Equipment………………………………..91,000

Gain on Disposal of Fixed Assets……5,000

a. $9,000 [($91,000 – $10,000) ÷ 9]

b. $5,000 gain: $78,000 – [$91,000 – ($9,000 × 2)]

3 Follow My Example 10-6

10-62

Compute depletion and journalize the entry for depletion.

4

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10-63

The process of transferring the cost of natural resources to an expense account is called depletion.

Natural Resources

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10-64

A business paid $400,000 for the mining rights to a mineral deposit estimated at 1,000,000 tons of ore.

Step 1: Determine the depletion rate per ton.

Cost of ResourcesEstimated Total Units

of Resources

Depletion Rate =

4

10-65

$400,0001,000,000

$.40 per ton =

4


Step 1: Determine the depletion rate per ton.

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Step 2: Multiply the depletion rate by the quantity extracted during period.

$0.40 per ton × $90,000 tons = $36,000

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10-67

The adjusting entry to record the depletion is shown below.

4

10-68

Earth’s Treasures Mining Co. acquired mineral rights for $45,000,000. The mineral deposit is estimated at 50,000,000 tons. During the current year, 12,600,000 tons were mined and sold.

a. Determine the depletion rate.

b. Determine the amount of depletion expense for the current year.

c. Journalize the adjusting entry on December 31 to recognize the depletion expense.


10-80

Depletion

10-69

Example Exercise 10-7 (continued)

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c. Depletion Expense……………….. 11,340,000Accumulated Depletion..........

11,340,000 Depletion of mineral deposit.

b. $11,340,000 = (12,600,000 tons × $0.90 per ton)

4 Follow My Example 10-7

a. $0.90 per ton = $45,000,000 ÷ 50,000,000 tons

10-70

Describe the accounting for intangible assets, such as patents, copyrights, and goodwill.

5

10-82

10-71

Patents, copyrights, trademarks, and goodwill are long-lived assets that are useful in the operations of a business and not held for sale. These assets are called intangible assets because they do not exist physically.

5

Intangible Assets

10-72

The exclusive right granted by the federal government to manufacturers to produce and sell goods with one or more unique features is a patent. These rights continue in effect for 20 years.

Patent

5

10-73

At the beginning of its fiscal year, a business acquires a patent right for $100,000. Its remaining useful life is estimated at 5 years.

Amortizing a Patent

5

10-74

Because a patent (and other intangible assets) does not exist physically, it is acceptable to credit the asset. This approach is different from physical fixed assets that require the use of a contra asset account.

5

10-75

The exclusive right granted by the federal government to publish and sell a literary, artistic, or musical composition is a copyright. A copyright extends for 70 years beyond the author’s death.

Copyright

5

10-76

A trademark is a unique name, term, or symbol used to identify a business and its products. Most businesses identify their trademarks with ® in their advertisements and on their products. Trademarks can be registered for 10 years and can be renewed every 10-year period thereafter.

Trademark

5

10-77

In business, goodwill refers to an intangible asset of a business that is created from such favorable factors as location, product quality, reputation, and managerial skill.

Goodwill

5

10-78

Generally accepted accounting principles permit goodwill to be recorded in the accounts only if it is objectively determined by a transaction.

5

10-79

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10-96

Describe how depreciation expense is reported in an income statement and prepare a balance sheet that includes fixed assets and intangible assets.

10-80

6

10-81

• The cost and related accumulated depletion of mineral rights are normally shown as part of the Fixed Assets section of the balance sheet.

• Intangible assets are usually reported in the balance sheet, supported by a note with a separate listing.

• The balance in each class of intangible assets should be disclosed net of any amortization.

6

10-82

Fixed Asset Turnover Ratio

One measure of the revenue-generating efficiency of fixed assets is the fixed asset turnover ratio. It measures the number of dollars of revenue earned per dollar of fixed assets and is computed as follows:


Revenue

Average Book Value of Fixed

Assets

=

6

10-83

For Marriott International, Inc. (in millions)


Revenue

Average Book Value of Fixed Assets

=


$12,160

($1,238 + 2,341)/2 =

Fixed Asset Turnover Ratio= 6.79

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Appendix 2:Exchanging Similar Fixed Assets

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10-85

(see Slide 105)

10-86

Calculating the Gain

Price (fair market value) of new equipment $5,000Less assets given up in exchange:

Book value of old equipment ($4,000 – $3,200) $ 800Cash paid on the exchange 3,900 4,700

Gain on exchange of assets $ 300

10-87

Loss on Exchange of Similar Assets

This time assume that only a $675 trade-in allowance was allowed towards the purchase of the new equipment. Because the market value of the new equipment is $5,000, the cash paid on the exchange amounts to $4,325.

10 Fixed Assets and Intangible Assets Principles of Financial Accounting, 11e Reeve Warren Duchac.

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